Global M&A trends and risks
Powerful new forces shaping in the M&A landscape
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Global | Publication | May 2016
The network operators’ market is increasingly competitive and operators are constantly looking for ways to reduce their costs and streamline their business.
Telecoms infrastructure makes up a substantial proportion of operators’ capital investments and, in emerging markets, most of their operating costs. With the constant roll out of new technology (including, in many jurisdictions, 4G services), together with, particularly in emerging markets, increased demand and pressure for network capacity and coverage in rural areas, one way of freeing up cash for the development of their networks is for operators to share their towers with competitors or dispose of their towers to (and leaseback from) specialised tower operating companies (towercos). Tower divestment also leaves towercos to manage the ‘grass and steel’ side of the business whilst operators focus on their core business of technology and customer service.
This model is well established and actively encouraged by governments in many jurisdictions across the world. There is already an established towers market in North America and India, and the model is receiving increasing attention in emerging markets such as Africa, Central and Latin America and Asia (particularly in Myanmar, Thailand and Indonesia). Opportunities are plentiful throughout the cycle, from asset divestments by operators and debt raising by towercos, through mergers and acquisitions activity as markets consolidate, to IPOs and other exit strategies for towercos and their investors.
2015 thus far has seen the first full portfolio divestment in Africa (by Airtel), the headlinehitting acquisition of Crown Castle by Macquarie in Australia and the emergence of new markets in North Africa (with Eaton Towers entering Egypt) and the Middle East (with Mobily and Zain both looking to sell towers in Saudi Arabia).
This article offers an introduction to the “towerco” model and the different ways of structuring tower transactions, together with examples from our experience in advising on a number of transactions in the market.
The towers model is predicated on a desire of operators to release cash from their passive infrastructure. However, this is not only a cost-saving measure for network providers. The model also enables them to focus on their core business model of acquiring and servicing customers, and expanding network coverage and services in the midst of ever-increasing competitive pricing pressures, without having the distractions and complexities of operating passive assets. Whilst there are a number of variations on the model, the concept sees the operators divesting themselves of their towers and other passive infrastructure. The network operator will then lease space on the tower from the tower company for their transmissions equipment under long term lease arrangements. The leasing is a non-exclusive arrangement, enabling the tower companies to “co-locate” other operators on those same towers. The greater the number of tenants, the better for the towers companies (and their financiers), as this drives up revenues from largely the same base costs.
Tower companies also offer a “build to suit” service, by which they construct new towers for an operator, based on operator request as to location, specifications and timing together with colocation opportunities on other portfolios which the tower company acquires. Build-tosuit programmes are particularly common in emerging markets where network rollout is still in the process of being completed. By entering into these arrangements with tower companies, operators are able to reduce the future capital expenditure and operational expenditure associated with constructing and operating new towers. Generally, the ‘build to suit” model is also based upon non-exclusive tenancy, with tower rents for the operator who contracted the towers starting high and reducing with the number of operators who co-locate on each site.
There are a number of different legal structures available to implement the model. The most common of these is the sale and leaseback structure. Under this structure, mobile operators sell towers to an independent tower company. The towers are then leased back to the operator as well as other operators with whom the tower company has a relationship. The tower company is then responsible for the operation and maintenance of the tower.
The model can also be operated under an outsourcing structure. In this scenario the tower company does not obtain ownership of the towers, instead simply providing “managed services” for the network provider. For example, the first Eaton Towers transaction in Ghana, with Vodafone as the counterparty, was structured on the basis of this model. This model allows operators to reduce operational expenditure and obligation as tower companies are able to offer the same service for reduced costs for the operator, without relinquishing ownership of the towers.
The tower companies themselves also operate on a number of different legal structures. Some tower companies (such as Eaton Towers) are operated on a totally independent basis, with no legal connection to their network operator tenants. This structure allows operators to maximise the cash released on disposal of the towers.
Other tower companies have operations structured as joint ventures with their operator partner. This allows the operator to retain some equity in the joint venture tower company and in doing so benefit from the favourable arbitrage between operator and tower company valuations and in retaining a level of control over the tower business. However, in opting to form a joint venture, operators will reduce the amount of cash available from monetising their tower assets and this model also creates complexities in ensuring towerco independence. Another reason behind structuring tower companies as joint ventures may be regulatory requirements. In a number of jurisdictions there are legislative requirements for locally incorporated/ resident persons to hold telecommunications licences (including passive infrastructure licences) and interests in land. These restrictions are often addressed by the relevant tower company establishing a locally incorporated operating vehicle to own and operate the towers, which may itself be owned by foreign shareholders. However, some jurisdictions do impose a requirement for a minimum local ownership stake in the operating company and as such joint ventures between a state owned or local operator and an international tower company may offer a solution.
There are two broad types of infrastructure sharing; passive infrastructure sharing and active infrastructure sharing. Passive mobile infrastructure includes tower sites and all infrastructure on them, such as the towers themselves, cables, ducts, shelters and power facilities and cooling systems (but excluding radio equipment) and the sharing of such sites or towers is the main focus of this article.
Active infrastructure sharing involves an operator giving one or more third party operators access to all or part of its network. A tower company will generally seek to restrict operators’ ability to participate in active infrastructure sharing as otherwise a tenant operator could share its active infrastructure with another operator, removing the need for that operator to lease space on the tower for itself. As tower companies build their models on specific tenancy ratios, it is important that they are able to position themselves to attract new tenants. However, tower companies may also seek to use active infrastructure sharing to their advantage, by requiring operators who lease space on their towers to pay an enhanced rental fee should they wish to share their active infrastructure on such towers.
Increasingly, governments and regulatory bodies see infrastructure sharing as a way of achieving competition between network providers. Where a tower company has acquired the towers of an operator it can make them available to new smaller entrants thereby permitting them an easier entry into the market where they may otherwise have been constrained by the cost of rolling out a new network as well as the related infrastructure. In addition, where operators have sold their towers, the proceeds of sale and reduction in ongoing capex allows them to invest in new technologies and better network quality of service for the benefit of subscribers.
Other motivating factors behind mandated infrastructure sharing for governments and regulatory bodies are the social and environmental benefits. The divestment of towers by network providers allows for expansion into rural areas (where revenue generation is traditionally lower than in urban areas due to lower prospective tenancy ratios) which desperately require connectivity. In some cases rural connectivity is a condition of governmental bodies granting new licences and spectrum to operators. Certain jurisdictions have also imposed restrictions on building in high density areas to reduce emissions and in reaction to complaints that towers and their power generators are noisy, noxious and unattractive additions to the landscape. Furthermore, the operation and management of towers by independent tower companies avoids duplication of towers as fewer towers are required to service the needs of the network providers in any country. This has positive implications for the overall carbon footprint of the telecoms infrastructure, in particular in emerging markets where towers are often powered by diesel generators due to the unreliability of the grid.
However, it is worth noting that in certain jurisdictions the regulatory and licensing environment can act as a hindrance to the development of the tower company model. Specific passive infrastructure licensing regimes are in place across developed market jurisdictions and in many emerging market jurisdictions, such as Brazil and Nigeria, but in certain emerging market jurisdictions the regulatory and licensing regimes have struggled to keep up with the pace at which the tower company model has developed. As such, tower companies may find themselves being associated with operating companies and subject to a much more stringent licensing regime than may be appropriate for the more limited nature of their business, or not subject to any regime at all which causes uncertainty. Where this is the case, more involved dialogue with the telecoms regulator is necessary to understand requirements. For example, in Burkina Faso there is currently no passive infrastructure regime, yet on recent transactions the regulator has been looking to promote infrastructure sharing. Further, across emerging markets much of the regulatory regime can be slow, with permitting applications (as may be required for planning, building or environmental permits) in certain jurisdictions taking up to 12 months for approval, which is detrimental to business, although positive steps are being taken to address this issue in countries such as Brazil with the introduction of specific laws to promote and ease this process.
Typically, tower companies seek financing to enable the purchase of tower assets from operators and to fund refurbishment of towers and ongoing build-tosuit and development obligations. Whilst the “major” tower companies, such as American Tower and SBA Communications, are often funded from equity or by corporate debt facilities, junior tower companies, on the other hand, are often forced to obtain more structured financing.
Financiers of such structured debt will likely require a comprehensive security package and a parent company guarantee. The form of this security package will likely be a significant consideration for lenders, depending on the size of the tower company, its operating history and other credit factors. Lenders to smaller tower companies, or where the financing is structured on an off-balance sheet basis, will typically require security over the shares in the tower company together with security over the tower companies assets including licences and permits, tenancy arrangements, the towers themselves and sometimes the land on which they are situated. Security costs and perfection times can vary from country to country, but an understanding of these is very important from the perspective of any time and cost planning for a transaction.
The financing documentation for a towerco acquisition and development financing will typically include a comprehensive covenants package. Financial covenants will include leverage and debt service coverage testing. Lenders will also require covenants as to information in relation to and compliance with the terms of key transaction documents, together with security over these documents. Such key documents will include:
Given the potential social and economic benefits of the development of telecoms infrastructure to developing nations, there is a strong history of DFIs providing debt (and equity) to tower companies, both on a bilateral level and as part of combined financing structures. Commercial banks and DFIs will largely lend on similar terms within the same structured finance structure, albeit with certain variations in focus. In particular DFIs are sensitive to environmental and social risks and also sanctions and corrupt practices and will insist upon the inclusion of a strict covenant package in this regard.
For those mid-tier tower companies with a more established operating history, a bond issuance at parent company may be attractive. A bond financing would typically allow the tower company to operate more flexibly without many of the restrictions of a structured opco loan financing, and may also be more economically attractive in the longer term. However, loans are more adjustable to the needs of a developing tower company, whether by providing local currency and dollar financing and an ability to utilise the facilities over time as financing needs arise, as well as being more easily adaptable if the lenders are willing to accommodate change, based on the closer relationship between lenders and their borrower. As tower companies diversify and develop their portfolios, and acquire a good operating record, the bond market will become more available to them.
The towers model allows network operators both an opportunity to obtain a cash injection and an opportunity to avoid the cost and hassle of tower management. This hassle is particularly well-avoided in emerging market jurisdictions such as Myanmar, where in negotiations network operators push hard for towercos to accept responsibility and risk for things like permitting, security management, labour issues, and constantly changing government regulations and directives that impact on their ability to maintain tower sites. Operators also tend to press for the strongest obtainable penalties where towercos fail to deliver on site roll-out timelines (in a build-to-suit scenario) and service level agreements (for existing sites). Having an effective penalty scheme in place is seen as particularly important by operators who obtained their network licences through a competitive tender process which resulted in licences being conditional on network roll-out at a particular pace and to a particular service standard.
Another priority for many network operators is to be sure the towerco is not going to fall foul of any anti-money laundering or bribery and corruption standards. Many large network operators have financing obligations which do not permit them to deal with service providers who do not conform to certain standards for such matters, as well as obligations under international child labour and similar laws. This can sometimes present difficulties as the standards are often very stringent.
Pricing is, as always, one of the hottest issues. Many anchor tenant operators wish to see ‘most favoured customer’ clauses in a MLA, which commit the towerco to offering them the lowest rent of any tenant on a comparable site, together with other discounting arrangements. This is usually a source of contention in negotiations and can present additional difficulties when a subsequent tenant on a site requests the same clause.
The towerco model is predicated on a desire of operators to release cash from their passive infrastructure. However, not only is this a cost-saving measure for network providers. The model also enables them to focus on their core business model of acquiring and servicing customers, and expanding network coverage and services in the midst of ever-increasing competitive pricing pressures, without having the distractions and complexities of operating passive assets. Whilst there are a number of variations on the model, the concept sees the operators divesting themselves of their towers and other passive infrastructure. The network operator will then lease space on the tower from the tower company for their transmissions equipment under long term lease arrangements. The leasing is a non-exclusive arrangement, enabling the tower companies to “co-locate” other operators on those same towers. The greater the number of tenants the better for the towers companies (and their financiers), as this drives up revenues from largely the same base costs.
Tower companies also offer a “build to suit” service, by which they construct new towers for an operator, based on operator request as to location, specifications and timing together with colocation opportunities on other portfolios which the tower company acquires. Build-tosuit programmes are particularly common in emerging markets where network rollout is still in the process of being completed. By entering into these arrangements with tower companies, operators are able to reduce the future capital expenditure and operational expenditure associated with constructing and operating new towers.
The towerco model is developing globally, and is gaining traction across a range of emerging economies. Africa, South America, Myanmar and Indonesia are those leading the way in the current environment, as operators and governments align their interests in utilising and encouraging the model. The nature of activity in each market will depend on the stage of development of the same. In new markets, acquisitions and divestments and loan financing of the same will dominate the landscape, however in those markets where the model and towercos themselves are more established with diversified portfolios then bond financings and corporate activity, whether M&A or IPO, can be expected to be more widespread.
In each case, regulatory issues and legal documentation will be central to the ability of transactions to progress, and it remains crucial to the success of any transaction to have an in depth knowledge and understanding of the key issues at stake.
Nina Varumo is a freelance portrait and documentary photographer based in Stockholm. A recent project of hers Kvinnor till sjöss (‘Women at sea’) is on ongoing photo series highlighting the working life of female seafarers in order to change the stereotypical image of what and who is a seafarer.
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